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Federal Ministry of Finance on the repayment of nominal capital and the return of capital contributions in the case of third-country companies – Prospect of tax neutrality

Previously, the German fiscal administration held the view that in the case of corporations outside of the EU (so-called ‘third-country companies’) payments not made to nominal capital could generally not be returned in a way that would not affect the operating result for tax purposes. Following contradictory rulings by the Federal Fiscal Court (Bundesfinanzhof, BFH), the Federal Ministry of Finance (Bundesministerium der Finanzen, BMF) has now acknowledged this case law and put in place rules for the repayment of nominal capital. Nevertheless, various pitfalls can be found in the details as regards, among other things, the potentially exacting verification requirements.

Repayment of nominal capital

Generally, in the documentation, payments that have been made in a foreign currency at the level of the distributing company will have to be converted into Euro at the middle rate of the forex bid price. For the shareholder, repayments of nominal capital will normally result in a reduction in acquisition costs that would not be subject to income tax. There are two relevant exceptions to this.

  • If the repayments of nominal capital exceed the acquisition costs then the excess amount would generally be liable for tax.
  • Amounts that are repaid within five years after a capital increase from company funds have to be classified as income from capital assets up to the amount of this capital increase. 

The BMF, in its circular of 21.4.2022 (reference: IV C 2 – S 2836/20/10001 :002), stipulated that in order to be able to benefit from basic tax neutrality the nominal capital reduction and repayment resolutions, among other things, would have to be provided as proof of the repayment of nominal capital. 

Repayment of contributions not made to nominal capital

The fiscal administration has acknowledged that, in principle, the possibility of a tax-neutral repayment does exist. However, the authority wants to allow this, in accordance with BFH case law, only when and to the extent that, in accordance with the so-called ‘appropriation sequence’ – which is also of relevance for domestic (German) corporations -, profits are not paid out first. Since, in Germany, no assessments are made of the contribution account for tax purposes for third-country companies, the required amounts should be determined on the basis of foreign financial accounts on the last reporting date prior to the distribution and, therefore, carried out as follows:

– nominal capital
– additional capital contributions not made to nominal capital
= distributable profit  

The BMF circular specifies the extensive evidence that could be required if a tax-neutral repayment is supposed to be presumed. In particular, this could include: 

  1. proof of the unlimited tax liability of the distributing corporation or association of persons in a third-country for the requested period, 
  2. the size of the domestic shareholder’s participation, 
  3. resolutions and evidence of distributions made and 
  4. the balance sheet of the company making the payment.

Please note: The fiscal administration does not require financial accounts prepared according to German law nor a reconciliation to notional tax accounts. 

Particular feature – Corporations from EEA countries effectively have a right to choose

It is the view of the BMF that, upon application, it would be possible to also apply the provisions on the return of capital contributions to the corporations from EEA states that have to be taken into account by foreign EU corporations. If this has not been effectively requested then the principles described above would be applied.

Recommendation: The new BMF circular has provided increased application certainty. It is however likely that the fiscal administration will place strict requirements for producing proof on taxpayers who want to benefit from the above-mentioned tax neutrality. Therefore, you should make sure early on that you can secure access to the documents that might be requested.

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